Are our heads out of the sand?

 The SME universe is rapidly changing and evolving, with much of the unprecedented push happening as a result of the pandemic. SMEs have born the lion’s share of the economic turmoil and pressure that has crushed a wide array of key industries in the United States and EU including but not limited to those in the hospitality, restaurant and travel-related sectors. At the very same time, a series of recent events confirms that others view our industry as a very attractive and profitably one and they “want in.”

What we are seeing unfold is just the tip of the iceberg when it comes to entities poaching SMEs away from working capital firms; and the $64,000 question is this: are we ready to come out and fight for our positon in the SME funding world? Or will we bury our heads in the sand like an ostrich?

For as long as I can remember, the factoring industry has worried about the rapid growth of industries like FINTech. In addition, the MCA scourge has added a new set of well financed enterprises, which have been preying on SMEs seeking a quick and expensive working capital solutions. While these firms are clearly here to stay, I believe that a set of new entrants are the competitors that we really need to be worried about. As factors, we must step up our game if we want to remain a viable solution for SMEs globally.

Who are these new competitors? Consider that in the last 30 days alone in the midst of a turbulent economic environment, several events have taken place that we must be cognizant of as a sign of what the future will look like in the SME funding industry.

The first industry-changing event for factors was the recent announcement that the global giant, American Express, is acquiring the FINTech lender Kabbage. Financial terms were not announced but analysts have estimated the total transaction price was in the $800 million range. Kabbage began to market their online loan products to SMEs starting in 2009 and has since branched. The excellent name recognition and financial depth of American Express could make Kabbage 2.0 a fierce competitor. I have done a great deal of reading on what American Express has already said about their future plans for Kabbage from both industry sources and from American Express itself. Here are just some of the facts known so far;

1. American Express intends to integrate all of the Kabbage suite of products into a single online platform.
2. American Express is not buying the current loan portfolio [including $7 billion in PPP loans, allowing them to start with a 100% clean slate to build on.
3. The new entity will be managed and run on a stand-alone basis.

 So perhaps American Express gets the best of both worlds; the ability to immediately utilize Kabbage’s proprietary expertise [including learning-based algorithms] to seek SMEs who already trust the wide array of American Express’ services. And how many of these are currently clients of ours? A whole lot. American Express intends to “use multiple data inputs to build a more holistic view of an SME's financial status and more accurately assess credit risk, rather than making the lending decision solely based on credit score.” Does this sound like we are trying to do as factoring firms?

They also note that “they will leverage Kabbage’s wide range of third party data to assess creditworthiness, including traditional accounting statements, social media signals, and e-commerce transactions and will be able to make real-time credit decisions by cutting down the application process to less than 10 minutes. By doing so, they will be able to offer working capital solutions that are better tailored to SMEs than they may be able to find with an incumbent competitor.” Are factors and traditional banks incumbent competitors? You better believe it. How many factoring firms could respond to an SME seeking a solution like the one outlined above in 10 minutes or less?

This as you might know is American Express’s second acquisition in the SME sector in the last 2 months alone, and I doubt it will be their last. American Express bought a digital payment firm called Acompay in July 2020. So who might be the next 800-pound gorilla competitor to the factoring industry? American Express will surely be in the hunt.

But they are surely not alone. In late July 2020, Enova International bought the online SME lender OnDeck capital and will no doubt take the technology that OnDeck has pioneered in the SME working capital space and put it to work. This has all the makings of another significant, well-backed competitor. 

Another very interesting industry development that did not get a lot of press, Intuit [owned by Microsoft and had over $6 billion in revenue in 2019] recently unveiled a new business bank account feature that is marketed as a way to give SME owners an “easier time managing their finances”. Called QuickBooks Cash, the new product has a finance planning application that can help SMEs plan for the future, with 90-day cash flow predictions, including guesses on when invoices will likely be paid. This all seems harmless to the factoring industry and actually might be an excellent tool for SMEs.

But what did catch my eye was that Intuit also is as part of this service offering a new debit card linked to the SMEs Quick Books account that allows SMEs to spend directly from their Quick Books cash balances. Perhaps this is another way to reduce the need to factor B2B and or B2G Accounts Receivables by better managing other cash on hand by the SME.

What can we do as individual factoring firms and an industry as a whole to put ourselves in the most competitive position possible to deal with these new and very powerful competitors? What steps can we take now and over the near term to strengthen [or perhaps just keep viable] our role in serving SMEs with equitably priced and structured working capital?

I have spoken extensively that we as professional service firms need to seek ways to improve the quality and integrity of the working capital tools we market and provide the SMEs who depend upon us. This requires a never-ending process of honest self-assessment that can be humbling and painful at times, no doubt. In addition, we need to become more agile and work to identify and eliminate the ways we provide our working capital to our clients in a more “friction-less” structure. Finally, the need for complete transparency and impeccable integrity must continue to serve as the foundation of the way we serve our clients, employees, partners and communities.

All of these actions and efforts are perhaps quite obvious to combat the increasing number of new competitors we will almost surely see in the SME funding universe in the future. But I think the more relevant conversation about how the factoring industry can remain relevant should address this question in a perhaps unusual and backwards way. Namely, what should we as individual factoring firms and an industry not do when trying to compete and remain competitive and viable in the future?

The answer to this question I think is quite clear; we need to avoid being swallowed up the ostrich effect.

The ostrich effect is a term commonly used in behavioral finance discussions to describe what happens when investors choose to ignore negative financial information. It was first used in 2006 and is often attributed to a behavioral economist by the name of George Loewenstein at Carnegie Mellon University. His research looked at the reasons why investors seemed to stick their heads in the sand during lousy markets. Additional research Dan Galai and Orly Slade in 2006 also entitled “The “Ostrich Effect” and the relationship between the Liquidity and the Yields of Financial Assets” in the Journal of Business also discusses this effect and is very interesting reading.

They defined the effect as “the avoidance of apparently risky financial situations by pretending they do not exist". Later research widened the definition to be “the avoiding to expose oneself to [financial] information that one fear may cause psychological discomfort".

I think we need to pause this conversation for a moment and come to the defense of the poor ostrich, a much maligned and misunderstood creature of the animal kingdom. The ostrich has to feel like the Rodney Dangerfield of the animal kingdom as it seemingly gets no respect at all. I am sure you know, the ostrich does not really bury its head in the sand. According to the San Diego Zoo, when it senses danger and cannot run away, it flops to the ground and remains still with its head and neck flat on the ground in front of it. Because the head and neck are lightly colored, they blend in with the color of the soil.

 Nevertheless, we can all relate to the concept on a personal basis of choosing to “bury our own head” in the sand when we are faced with negative information. Research has shown that this effect does occur most often when we are emotionally invested in the information just received or learned. The pattern of behavior is amazingly clear to see; we are exposed or presented with information that we find discomforting or threatening, so instead of getting anxious and dealing with the situation at hand we make the choice to just ignore the information outright.

Ignorance might truly be bliss, but to pretend the problem will disappear into thin air rarely works. Our human tendency to have this form of selective hearing takes on many different costumes or disguises; we don’t go to the Doctor for fear of what the test results might be, the parent choosing to ignore patterns of behavior in their children that others clearly see and are concerned about or horrified about, a CEO ignoring data and facts about the actual performance of a business unit or new acquisition, and many, many others. I myself admit that I have successfully [or at least I try to tell or mislead myself into thinking this has worked] avoided watching any television in this current COVID-19 pandemic period so I can avoid getting anxious or angry about how we have reacted to deal with the human tragedy that it truly is.

One of the other more interesting aspects of Loewenstein’s research was that the effect also predicts that people or investors may actually delay seeking and getting additional information, even when doing some can degrade the overall quality of the decisions being made. He looked at the difference in investor behaviors in good and bad markets and found that when things were good, investors would almost always look for information on their investments frequently. However, when things were bad or their investments were performing poorly, investors tended to ignore the information given to them and actually checked the performance less often.

So I think we all agree to pretend away new and powerful competitors is not a strategy that can ever work out well. To make no decision to put together a cohesive game plan is really a decision headed for in most cases eventual failure. If this is an accurate statement, what can we do as individual factoring firms and an industry collectively to be proactive and step up to future competitive challenges?

I certainly don’t pretend to know or have all of the answers to this query. But I think one excellent place to start this conversation is openly and honestly know that the ostrich effect is real and can be a very damaging force blocking progress and jeopardize the future viability and success of our factoring organizations. I did a lot of additional reading and research on how to quell this effect and one of the best sources of research and very thoughtful data on this can be found in the 11 article series entitled “Bias Busters” on the McKinsey & Co. website.

The most recent research in this insightful series is entitled “Bias Busters: Lifting your head from the sand” and was published by Eileen Kelly Rinaudo on August 18, 2020. Ms. Rinaudo is a senior knowledge expert in McKinsey’s New York office, and the article outlines a series of practical steps we can all use to lift our heads out of the sand. She makes a strong case in her work that “business conversations work better when business leaders actively acknowledge potentially unpleasant information rather than run from it.”

As we already discussed, her work initially looks at the cognitive bias called the “ostrich effect,” in which individuals figuratively put their heads in the sand and avoid information they believe may be unpleasant. Specifically, they may ignore the information presented to them, or they may interpret that information in a way that ignores potentially troubling implications.

One of her very interesting and practical way to lessen the chance of the ostrich effect taking over is for all involved in the conversations to engage in a readout process in which individuals or teams produce an articulated summary of discussions as they occur. She notes that a real--time readout gives everyone the information they need to make good decisions and that it can also increase the likelihood that everyone will step away from meetings with the same understanding of what was just said.

She provides a five step process that we can all learn from and use in this readout process;

1. Syndicating an agenda early,
2. Designating a scribe, and then, for each topic on the agenda,
3. Capturing critical points,
4. Sharing those points with the full group, and getting
5. Verbal confirmation from all attendees that the summary reflects their understanding of the discussion.

She concludes that “plainspoken and practical, the readout process imposes accountability on everyone in the room and can reduce the risk of misinterpretation during business meetings.” I agree!

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Mark Mandula is National Sales Manager of Florida-based alternative finance firm United Capital Funding. The firm provides commercial finance opportunities to small businesses with B2B and B2G relationships by funding accounts receivables. Learn more at ucfunding.com.